A TPP without the US now set in motion: Japan should lead trade talks in Asia

Mr. Donald Trump, who became US president with the support of constituents in the Rust Belt-the part of the country where steel and other heavy industries are in decline-is demonstrating an anti-free trade stance. This is characterized by the US withdrawal from the Trans-Pacific Partnership (TPP) and his administration's disregard for the World Trade Organization (WTO). The problem with Mr. Trump is that he is shackled by an old way of thinking that was prevalent in the 1980s. He does not understand that global production is inseparable from global supply chains. The days of the 1980s that tormented Japanese trade negotiators are now gone. They no longer need to fear the prospect of a free trade agreement (FTA) between Japan and the US. What's more, if a TPP without the US is reached among the remaining 11 signatories as a "TPP 11," Japan will have the upper hand over the US. Conversely, if Mr. Trump removes Japan's high tariffs on agricultural produce, Japan's agriculture will undoubtedly be set free from the fetters of the country's misguided farming policies and gain the potential for new growth.

Anti-globalism in the US

Trade was more of an issue in last year's US presidential election than any other. During the Democratic Party's presidential primaries, Senator Bernie Sanders, who started out as a fringe candidate, garnered much support by advocating anti-globalism. Along with others, he stressed the need for the US to withdraw from the TPP.

During the presidential election, Mr. Trump of the Republican Party maintained that American jobs had been lost because of free trade and immigrants. It was the first time since 1936 that a Republican Party presidential candidate had argued against free trade. Mr. Trump won Ohio, Pennsylvania, and other impoverished Rust Belt states, which are characterized by steel and other smokestack industries. These states were originally strongholds of the Democratic Party, which is backed by the labor unions.

After assuming the presidency, Mr. Trump announced his intention to withdraw from the TPP. The pact was unpopular even within the Republican Party mainstream, which advocates free trade. Senate Majority Leader Mitch McConnell criticized the fact that tobacco control had been made exempt from the investor-state dispute settlement (ISDS) clause, a clause which allows investors to sue host states before an international arbitral tribunal. Mr. Orrin Hatch, chair of the Senate Finance Committee-which was in charge of approving the TPP-called for TPP renegotiations. He expressed dissatisfaction that the period during which the pharmaceutical industry was required to protect its data for new drugs had been set at eight years instead of twelve years as stipulated under US law. Mr. Trump, who was against free trade, and the Republican Party mainstream, which argued that sufficient trade benefits were not expected from the TPP, were united against the deal.

As long as Mr. Trump remains US president, it is unlikely that the TPP will take effect; the pact is designed so that it will not come into effect unless Japan and the US take part. Apart from the TPP, Mr. Trump also made some remarks, during his presidential campaign, that were intended to deter trade partners of the US. In particular, he said: (i) if Japan imposes a 38% tariff on beef from Nebraska, he will impose a 38% tariff on Japanese automobiles; (ii) he will impose a 45% tariff on imports from China, which he said was manipulating exchange rates to boost exports to the US; and (iii) under the North American Free Trade Agreement (NAFTA), Ford Motor Company and other US auto manufacturers had transferred their plants to Mexico, resulting in cheap cars being imported to the US.

Although Mr. Trump's claims are full of aberrations, it was the US citizens that chose him as US president. The discontent of many US citizens who had been politically neglected and denied access to the benefits of economic growth catapulted Mr. Trump to the US presidency. President Trump created a series of scandals that would have rocked past administrations. Even so, these constituents' support for him remains unwavering.

A gap in thinking between 40 years ago and the present

The Trump administration's ideas about trade negotiations have not changed since the days of Japan-US trade friction in the 1980s. They still think that a country with a large trade surplus must be engaged in unfair trade practices. They are also frustrated by the fact that US automobiles do not sell well in Japan. Mr. Trump is trapped by old views that were popular in the 1970s and 1980s when he was in his youth.

The Japanese government must have a range of evidence to refute such views. A trade surplus or deficit stems from a macroeconomic imbalance; it has nothing to do with trade barriers. If Washington argues that a large trade surplus is the result of unfair trade practices and therefore needs to be reduced through bilateral talks, it must prove that Saudi Arabia and other oil-producing countries are conducting such practices toward Japan. If US officials want to know why US automobiles do not sell well in Japan, all they need to do is to come to Tokyo and ask Japanese people whether they want to buy a US car.

More essentially speaking, Mr. Trump, being originally a realtor, does not understand that global trade and the global economy have changed significantly. In the past, everything-ranging from parts to finished products-was produced in a single country for export. Currently, however, the world economy is built on global supply chains. When production was discontinued at paint factories in Japan's Tohoku region in the wake of the Great East Japan Earthquake in 2011, auto plants in Detroit had to suspend production. Now, parts account for 60-70 percent of international trade. If the Trump administration raises tariffs on automobiles produced in plants in Mexico in a bid to protect the employment of auto workers in Michigan, workers at US manufacturers that export auto parts to Mexico may lose their jobs. Today, there is no such thing as a purely made-in-USA product or a purely made-in-China product. As such, the rules of origin-which entail the question of what scope of products involving industries within an economic region should qualify for low and preferential tariffs-constitutes an important issue at FTA negotiations.

If the trade policy of the Trump administration succeeds and fewer jobs in Mexico is the result, more immigrants from its southern neighbor will come to the US. If the cost of building a wall along the national border was financed by tariffs from Mexico, these costs would be ultimately borne by US citizens, who would have no choice but to buy more expensive products. (The dilemma is that the more import-impeding effect the tariffs have, the fewer imports will result, which means smaller tariff revenues.)

The Trump administration stated that the US will not be bound by any WTO decisions unfavorable to the country in the annual report on trade policy it recently submitted to Congress. The tariffs the US commits itself to the WTO are generally low-2.5% for automobiles, for example. A tariff of 45% is rare. As Mr. Trump maintained during his presidential campaign, if the US was to impose a general tariff of 45% only on Chinese imports, that would clearly go against two articles of the General Agreement on Tariffs and Trade (GATT), which govern merchandise trade in the WTO Agreement. Article 1 provides for the principle of most-favored-nation treatment-the principle of treating nations equally in international trade. Article 2 prohibits member states to set tariffs higher than their own commitments.

Such action by the US would be counterproductive. If China brings it to the WTO dispute-settlement procedure, China will surely win. The WTO will recommend that the US take corrective action. The latest US annual report on trade policy states that the US will not be bound by such recommendations, meaning that the US would not retract its statement that it will impose a general tariff of 45%. This particular action is permissible under the WTO Agreement. Even if the US violates the pact, it does not need to take corrective action. Under the international legal order, there is no global power that can impose specific action on sovereign states. Instead, the WTO Agreement allows member states to take countermeasures against those states that have sued them. China will be allowed to significantly raise tariffs on imports from the US.

In fact, there are many cases in which the US or the EU has not taken recommended corrective measures after it lost its case at the WTO in exchange for allowing retaliatory measures. The Brazil-US cotton dispute and the US-EU beef hormones dispute are just two examples. The latest report only approves such actions by the US or the EU.

If both the US and China maintain high tariffs, trade between the two countries will shrink significantly. Free economic activity, however, tries to achieve its purpose by avoiding such high tariffs. For example, China businesses can first export their products to Country A and then re-export them to the US from that transit point. US businesses would do the same. In this way, any policy-induced distortions will be corrected by free economic activity.

Countries with minimum tariffs like Japan lend themselves best to such a transit point. If China exports products to the US by way of Japan, the US will likely impose similar high tariffs for Japan as it does for China, branding the practice as roundabout or circumvention trade. If that happens, Japan will bring the case to the WTO. This will result in Japan and the US imposing high tariffs for each other just as the US and China will be doing for each other.

If that instigates an economic chain reaction, higher tariffs will result between the US and other major economies worldwide. This means that high tariffs will be applied to both US imports and exports. Needless to say, bilateral trade that does not involve the US-trade between Japan and China, for example-would be business as usual. The US will practice protective trade alone in isolation while the rest of the world practices free trade on the back of low tariffs committed under the WTO. In that case, US products will not sell well and US consumers will have to pay a high price. The "US-first" policy will torment the nation.

Just reject a Japan-US FTA

Mr. Trump is set to forge ahead with bilateral FTAs rather than mega FTAs involving many countries like the TPP. He seems to believe that it is easier to press US demands that way.

During the 1980s, Japan had a hard time in trade talks with the US. There were two major reasons for this. First, in a political climate overshadowed by the Cold War, Japan had no choice but to accept US demands. Second, Japan had a weak point in that it protected key agricultural products such as rice and beef with import quantity restrictions that contravened the GATT. These circumstances are now gone. In addition, with the WTO in place, Japan now has recourse to this international legal order in rejecting unreasonable demands from a superpower. During the 1980s, Japan was terrified by the prospect of the possible application of Section 301 of the US Trade Act of 1974, which authorized the President to unilaterally retaliate against any nation he was dissatisfied with while serving as both "prosecutor" and "judge." However, the WTO negated Section 301, arguing that any retaliatory action must be preceded by its dispute-settlement procedure.

If the US calls for negotiations to reach a Japan-US FTA, Japan should just reject such a request. All Japan needs to do is to convince the US that a Japan-US FTA is undesirable, based on the following two-tier logic. First, TPP has been defined as one of the initiatives aimed at achieving a free trade area for the whole Asia-Pacific Economic Cooperation (APEC) region, i.e. the Free Trade Area of the Asia-Pacific (FTAAP). It is inappropriate to veer off the course that APEC leaders have committed themselves to and seek a bilateral FTA instead. Second, the accumulation of bilateral FTAs will result in confusion of multiple rules and regulations becoming entangled with one another. Jagdish Bhagwati, a renowned scholar of international economics, brands this phenomenon the "spaghetti bowl effect." A mega FTA has the major advantage that the rules and regulations will be unified among the many participating states.

The Japanese government has eventually decided to go ahead with TPP 11, a TPP without the US. It seems that what I have repeatedly proposed since last summer has been accepted as a consensus within the government.

Until the end of last year, Japanese government officials remained obviously reluctant to study what I had proposed. They cited an array of excuses, saying that a TPP without the US would be meaningless and that the TPP signatories who made concessions in one sector in exchange for greater access to the US market in another would demand renegotiations.

Earlier, Japanese officials made a major mistake in the TPP negotiations. They refused to abolish tariffs on agricultural produce. In return, they failed to increase access to the US market for Japanese automobiles. They had to agree to a vehicle tariff reduction schedule in which Japanese automobile manufacturers would have to compete in the US market with a handicap that would last for an overwhelmingly long time. The current 2.5% tariff on Japanese cars would remain unchanged for 14 years and begin to be reduced in the 15th year-to 2.25%. It would be halved to 1.25% in the 20th year and be lifted altogether in the 25th year. The current 25% tariff on trucks would remain unchanged for 29 years before being eliminated in the 30th year. By contract, US tariffs on South Korean automobiles will be scrapped in 2017 under the US-Korea FTA.

It is worth pointing out that Japanese businesses can still export their products to the US as usual even if the US does not participate in the TPP. Surprisingly, some people in the business community as well as those in the media and the political world believe that unless the TPP is in place, Japanese businesses cannot export their products to the US.

The TPP will increase access to Asian markets. These markets are not limited to industrial product markets in developing economies that have been protected with high tariffs. Government procurement markets that involve public works projects will be opened as well. This must be good news for Japanese general contractors. The TPP includes a provision which allows consignees to receive cargo within six hours from the start of customs clearance procedures if they require a rush shipment. This arrangement will contribute significantly to the development of logistics networks in the Asia-Pacific region.

As far as a TPP 11 is concerned, the tide turned presumably when the Trump administration clarified its stance to call for talks to reach a Japan-US FTA. The Japanese government began to worry that in such talks, the US would pressure Japan to make further commitments than those Japan made in the TPP negotiations with regard to agricultural produce. If a TPP 11 is launched first, the US will have to pay a tariff of 38.5% in order to export beef to Japan while Canada and Australia will have to pay a tariff of only 9%. The same thing will happen with wheat, pork, wine, butter, and cheese.

US agricultural products will be ousted from the Japanese market, and associated jobs will be lost accordingly. If Japan concludes an FTA with the EU-a major exporter of wine, pork, cheese, and pasta-the position of the US in trade talks with Japan will be critically undermined. A similar thing will happen in the markets of other TPP signatories.

The US will have no choice but to apply for accession to a TPP 11. The members of a TPP 11 will not have to take any heed of any request from the US. For its own part, the US will have to accept requests from the 11 members, including calls for the immediate abolition of tariffs on Japanese automobiles. Now that the US has withdrawn from the TPP, the special import quota of 70,000 tons for rice that Japan conceded to the US is no longer valid. Japan has no obligation to accept this quota even if the US applies to join a TPP 11.

In domestic politics, the Democratic Progressive Party and other opposition parties will lose their cause to oppose a TPP. Almost all anti-TPP arguments stemmed from a "morbid fear of the US." The case that US firms will take advantage of the ISDS clause to sue the Japanese government, resulting in Japan's regulations for protecting healthcare and food safety being changed for the worse, will no longer be valid.

Vietnam, one of the 11 remaining signatories to the TPP, has been reported as being reluctant toward a TPP 11 as it made concessions in the regulations on state-owned enterprises in exchange for greater access to the US textile market. However, Vietnam's concerns will be dissipated if the US rejoins the TPP; after all, a TPP without the US is a trick to persuade the US to join. The Japanese government must have convinced its Vietnamese counterpart based on my argument as described above. In June, Vietnam turned positive, clearing a major impediment to a TPP 11.

Despite the US withdrawal from the TPP, the high level rules that have been established under the pact will serve as a useful reference for many potential mega FTAs as well as for WTO negotiations. The participation of major states such as Canada, Australia, and Mexico will mitigate the spaghetti bowl effect. What is more, many countries and territories including South Korea, Taiwan, the Philippines, and Indonesia have all expressed their willingness to join the TPP. If China follows suit, the US will find itself in a difficult position from a geopolitical perspective as well. If the US says it wants to rejoin the TPP, the 11 signatories might as well accept such a request.

The Trump administration is now refraining from taking any major action on trade issues in expectation of China's cooperation in addressing the North Korea issue. It will not call for negotiations toward a Japan-US FTA for some time. The key here is to reach both a TPP 11 and a Japan-EU free trade agreement before the US establishes its strategy on trade negotiations.

A changing US and Japan

When Mr. Trump announced the withdrawal of the US from the Paris Agreement on global warming, he stated his intention to put the US first to secure American jobs. He said that the aim was to reciprocate the support from constituents in the rust belt city of Pittsburgh, Pennsylvania. This statement invited fierce protest from the mayor of Pittsburgh. The mayor said that the citizens of Pittsburgh had not chosen Trump in the presidential election. He also expressed his support for the Paris Agreement.

Mr. Trump seems to believe that Pittsburgh is a rusty steel city. However, the city has transformed itself into a community that revolves around health care, education, and finance. The University of Pittsburgh Medical Center is a gigantic complex of medical facilities with a total staff of 55,000 and total sales of more than one trillion yen. The Pittsburgh Steelers, the local professional American football team that faltered along with the local steel industry, has successfully rejuvenated itself. The team won the Super Bowl championship in 2006 and 2009.

In the US, the share of the manufacturing industry in gross domestic product (GDP) has now fallen to around 10% while service industries such as health care and finance account for about 80%. The city of Detroit, which failed to relinquish its heavy dependence on the auto industry, saw its finances collapse. Mr. Trump will not be able to afford to continue depending on support from the Rust Belt. When he becomes unable to do that, Mr. Trump will probably make a fresh move to embrace the TPP.

Conversely, Mr. Trump might act otherwise, unlike former President Barack Obama, who was sensible and moderate in his action. He might single out for criticism Japan's subsidies which encourage farmers to produce more rice for feed use resulting in the substantial reduction of imports of corn from the US and bring the case to the WTO. Or he might demand that Japan abolish tariffs on rice and other agricultural products as part of the bilateral FTA negotiations. In that case, Japan will not be able to keep the domestic prices of such products higher than international standards. That, in turn, will free Japanese consumers from the shackles of having to shoulder the burden associated with the country's erroneous agricultural policies; it will also open a new door for Japan's agriculture. That is the slight silver lining under the Trump administration.

(This article was translated from the Japanese transcript of Dr. Yamashita's column in "Kinyu-zaisei Business" on July 3, 2017.)